Businesses flip-flop on electricity deregulation

A Pittsburgh metals company with 3,500 employees in western Pennsylvania is trying to decide whether to make a major expansion here or in another state with better electricity rates.

As Allegheny Technologies weighs its options, company officials have been up front about what they consider to be the biggest strike against Pennsylvania: electricity deregulation.

It wasn't supposed to be this way. In the 1990s, industrial energy customers such as Allegheny Technologies were among the first and most forceful advocates of ending the state's traditional regulatory control over the electric industry. They wanted prices to be determined by market forces.

More than a decade later, that radical transformation is nearing completion. But now the industrial customers are among its most vocal critics.

"We're asking for a competitive market that's truly competitive?not on a fictitious market," said David Kleppinger, a Harrisburg lawyer whose clients include the Industrial Energy Consumers of Pennsylvania.

Former Public Utility Commissioner Terry Fitzpatrick, who as a legislative aide was at the table when the state's deregulation plan was drafted, characterized industrial customers' dramatic shift as "one of the great ironies of this whole thing."

What drove deregulation's biggest proponents to the other side of the debate? The answer, of course, depends on whom you ask.

Energy companies and other supporters of deregulation say industrial customers, and just about everybody else, are having trouble getting used to the idea of paying market rates for a commodity whose price has been virtually frozen since 1997.

For example, PPL Electric Utilities, a subsidiary of Allentown energy company PPL Corp., is expected to raise the price of electricity about 30 percent on Jan. 1, 2010, when a cap on what it can charge retail customers for electricity expires. (The cap was intended to shield homeowners and businesses from price surges caused by the transition from regulation to market-based pricing.)

PPL says the looming hike is largely a reflection of higher fuel costs. The prices of the coal, uranium, oil and natural gas on which power plants run have risen sharply in recent years.

"Naturally [industrial customers] don't like those prices," said PPL spokesman Dan McCarthy. "They've been shielded from those prices for a long time."

The industrial customers, however, argue fuel costs do not fully explain the rise in electricity prices. They say the real problem is the electricity market itself -- in particular, a feature of the market called marginal pricing.

The control room

In an underground room of an unmarked building at a nondescript industrial park in Valley Forge, Chester County, an illuminated power-grid map stretches across a wall 30 yards long and 10 feet high. Below, about 10 people quietly work at their computer terminals.

This is the control room of PJM Interconnection, a nonprofit organization that manages the electricity market. PJM likens its role to that of air traffic controller: Air traffic controllers don't own planes, they just tell them where to go. Similarly, PJM directs the electricity generated at 1,200 power plants to utilities and other wholesale customers in parts of 13 states and the District of Columbia.

Before deregulation, electricity under PJM's control sold for a slight mark-up over production costs. In Pennsylvania, the mark-up was determined by the state Public Utility Commission.

Now, under marginal pricing, electricity generated from cheap coal or nuclear fuel sometimes sells at the same price as electricity from expensive natural gas: A megawatt-hour of electricity that costs $35 to make at a coal-fired power plant or $25 at a nuclear plant might sell for $70 -- the going price of a megawatt from a natural gas plant.

When this happens, it makes for higher electricity prices -- and profit for energy companies. That, at least, is the immediate result.

But the long-term impact of marginal pricing is quite different, according to economists who support it. They say it encourages power plants to run as efficiently as possible; if plants don't, they might not find a buyer for their higher-cost electricity when demand is low.

That's because, in times of low demand, the plants that cost more to run won't even be asked to come on line. And this means the plants that cost less to run set the market price.

Academic explanations, however, have done little to persuade industrial customers. Their attention is focused on energy companies' skyrocketing profits.

This summer, PPL, which serves 1.4 million Pennsylvania customers, reported its biggest-ever quarterly earnings, $345 million. The sale of an El Salvadoran subsidiary contributed to the record. But second-quarter earnings from operations, which exclude such gains, also were exceptionally strong.

The story is similar at Exelon Corp., the parent company of Philadelphia-area energy company PECO. Exelon reported its profit on electricity sales in the second quarter of 2007 was $35.97 per megawatt, compared with $26.43 a year earlier -- an increase of 36 percent.

Sensitive to the scrutiny such numbers invite, PPL and Exelon insist any contribution marginal pricing makes to the bottom line is minimal. Both say new long-term electricity contracts, which account for the vast majority of their sales, are what's really driving up profit.

Joe Hopf, president of PPL's electricity trading operation PPL EnergyPlus, said that, when setting long-term electricity contracts, he considers many factors, such as fuel prices and environmental costs, but not marginal price.

"Marginal pricing does not lead to higher energy costs," he said "It is a tried and true method for ensuring that the most efficient and cost-effective power plants are running."

Electricity is not grain

Another consequence of marginal pricing, according to Kleppinger, the industrial customers' lawyer, is that it undercuts what was supposed to be one of the primary benefits of deregulation: choice.

Electricity deregulation unfolded in two stages. First, in 1992, the federal government made possible wholesale competition by mandating that utilities open their transmission grids to outside electricity generators. Then, individual states moved toward retail deregulation.

Retail deregulation promised to end electric utility monopolies: Customers -- from homeowners to factories -- would be able to shop around for electricity, choosing from among a variety of providers.

In Pennsylvania, retail electricity deregulation legislation was signed into law by then-Gov. Tom Ridge in 1996.

Alternatives to traditional utilities, though, have failed to take root in most parts of the state. In the PPL service territory, for example, most consumers have only one source of electricity, the same one they've always had: PPL.

But even in parts of western Pennsylvania, where customers do have some choice, the difference in prices offered by the various electricity providers is negligible, Kleppinger said.

"Is it a meaningful choice?" he said. "The answer would be no."

The underlying issue, Kleppinger explained, is that electricity is different from other commodities: It cannot be stored like, say, grain. And it has no substitute. If the price of corn goes up, you can switch to rice. But there's no realistic alternative to electricity when it comes to lighting your home.

"The economic theory of marginal pricing is difficult to rebut?But it breaks down on this commodity," he said. "The benefits do not flow down to the consumer."

Energy companies, meanwhile, are calling for patience. They blame the price caps that have kept electricity prices frozen near 1997 rates for undermining competition.

"It is impossible for competitive suppliers to beat the price currently being offered by PPL," PPL spokesman McCarthy said. "The expiration of price caps is likely to result in additional marketplace offers from competitive suppliers, giving customers -- especially larger customers -- more options."

The question for Pennsylvania is whether industrial customers such as Allegheny Technologies will be willing to wait and see if that happens.

"I really don't think deregulation is in the best interest of the people of western Pennsylvania," Allegheny Technologies Chief Executive Officer L. Patrick Hassey said at the company's annual meeting in May.

Allegheny Technologies spokesman Dan Greenfield elaborated in a recent interview: "A manufacturer has to have reasonable prices for electricity that are stable."

Over the summer, Gov. Ed Rendell signed legislation intended to appease industrial customers. It helps them to avoid price swings by allowing longer-term energy contracts.

In the competition to host Allegheny Technologies' expansion, Greenfield said, the new law has moved Pennsylvania to "a better position than it was before."

THE RISE OF DEREGULATION

Traditionally, electric utilities owned and controlled the power plants and the transmission grid within their service areas; because they were monopolies, their rates were regulated by the government. A new way of doing business emerged in the 1990s.

1992 -- The federal Energy Policy Act signed by President George H.W. Bush makes possible wholesale electricity competition by mandating utilities open their transmission grids to outside electricity generators.

1998 -- PPL Corp., under Chief Executive Officer William Hecht, is the second energy company in the state, after PECO, to reach an agreement with the Pennsylvania Public Utility Commission on a long-term plan to move from regulation to market-based pricing. The plan includes a rate cap on what the company can charge for electricity generation.

2001 -- California experiences rolling blackouts as energy companies manipulate the nascent electricity market to create power shortages. This prompts some states that were moving toward deregulating their own retail electricity markets to reverse course.

2010 -- The cap on what PPL Electric Utilities can charge customers for electricity generation will expire. As a result, the price of electricity is expected to increase 30 percent.